The way the sovereign of a democratic government is evolving, the actual sovereign in money. That's where the power lies, under everyone's consent. Governments would do a lot these days, but not something fundamental. Honour of financial ties above all.

In the USA there is nothing to prevent the Treasury from ordering the Comptroller of the Currency from printing more, and even larger, bills. The Greenback dollars from the Civil War period were produced by an agency of the US Government and we could do so again.

But the far more significant power is for the government just to credit checking accounts for purposes it chooses. It currently does this with income tax refunds, Social Security payments, Medicare, etc. The vast majority of "money" is just electronic credits and debits.

Modern Monetary Theory holds that governments can spend on socially necessary functions, especially in times of unemployment, up to the level that will start to produce increases in the cost of labor without having any inflationary effect. What happens is that socially needed tasks get done by labor that otherwise would have been unemployed. The economy and society thus benefit from production that otherwise would have been lost forever. People who are capable of doing useful things cannot go back and work on a previous day when they were involuntarily unemployed.

Bill Mitchell at BillyBlog and Randal Wray, Michael Hudson and others at New Economic Perspectives have written extensively on this subject. Crediting someone's account actually does not "print money" although the account holder could certainly turn the credit into cash should they so wish. A better term for this would be that by so doing the Government "spends money into creation", while taxes take money out of the economy. I don't pretend to understand all of the details of this but I can see that theories of economics that include monetary models that are not congruent with how the system actually works are not going to give good or useful results. Those who would criticize government spending in times of recession always resort to arguments based on false premises as to how our monetary system works.

A better term for this would be that by so doing the Government "spends money into creation",

Private banks do just the same when they credit the accounts of suppliers; staff; management; shareholders; or anyone who has sold them a financial or other asset.

When they are doing this they are instantaneously creating the demand deposits for the recipients, in just the same way they instantaneously create demand deposits when they create credit as interest-bearing loans.

If a private bank can do it, why not a public bank?

"The future is already here -- it's just not very evenly distributed"
William Gibson

Why indeed! California could solve a lot of its problems just now by creating its own Bank of California to handle all California State expenditures and tax receipts. The problem consists in insuring that the bank is run prudently and honestly. Else it could just turn into more insider looting.

How much do the governments "spend money into creation"? The way its happening is through greater national debt - which means that the society and the folks (even if receiving "handouts") become increasingly indebted to bond holders - and the governments look ready to enforce that relation strictly.

The other side of sovereignty is the power of the banking investors. As some bankers hold more money than most of sovereign nations combined, they are apparently hold more authority and power as well. Say, the known examples of hyperinflation (and non-inflation, as in Nazi Germany) rather show the free will of international financiers than vanity of press printing. If governments were to exercise radically the sovereignty in legal tender matters, what we can expect from those winning everything now? Wouldn't there be a difference between nominal and real (through astutely hidden) sovereignty.

...while taxes take money out of the economy

This is not clear to me. Government activity has expenses, and it is a part of the economy. In the system that is working now, money is taken out by paying back debt.

When the private sector has made a mess of things and is justly afraid to invest their own money in the environment that their actions has created there are two options:

Wait until things sort themselves out. If the economy goes into a debt-deflation spiral this might take a long while and result in a collapsed society.

The government can spend directly on projects that will provide a return on the investment. Just now that would be renewable energy and electric rail transport in the USA, but green transport friendly affordable housing would also qualify. Almost anything useful would qualify, but why not concentrate on the most important needs? Capital spending projects do actually stimulate the economy as work is being done on things that do not result in immediate consumption. That increases demand for consumption goods. This is more helpful if your economy actually produces consumer goods -- a bit of a problem in the USA, but it is still helpful.

Numerous studies have shown that such government intervention is less costly in the long run than doing nothing, especially when there are social programs such as unemployment insurance that increases during recessions -- i.e. when the private sector has messed things up.

Just now the private sector has created what is probably a bigger mess than was created after the Crash of '29, so the intervention should be larger. It is not that such deficit spending is a good in and of itself, it is that it is far superior to doing nothing. Even better would be a re-regulation of finance to insure against a repeat of this calamity.

This discussion is drifting sideways, but anyways. The problem with Keynesian deficit spending is deficit spending. The governments just do not "spend money into existence". The feel obliged to borrow money from the "existing" capital and then spend it. Nasim Taleb has already have enough of this reciepe.

There is also a third possibility of your list - the crisis is so deep that no Keynesian spending, however gross, would wake the conventional economy up. A paralyzed economy is only a symptom. The problems won't be solved while stiffing (to some, very comfortable to others) amount of debt is out there.

While the sovereign does not need to issue bonds in order to fund deficit spending (because the sovereign, being able to enforce legal tender laws, does not need to fund deficit spending at all), it can sometimes be a good idea to issue bonds in a volume that happens to coincide with the amount of deficit spending.

Imagine that you are deficit spending because you are in a balance sheet recession. The fact that you are in a balance sheet recession means that a lot of the legal tender you deficit spend is going to end up in somebody's mattress, to offer collateral against potential margin calls.

This is not really a problem - after all, you can just deficit spend more. But what happens when you have lifted the economy out of depression? Why, all the legal tender that was hidden in mattresses to guard against margin calls that never did come (partly because you were deficit spending to get the economy afloat again) is going to come out of those mattresses.

This is why you want to, during the recession, exchange some of the legal tender in the mattresses for T-bonds. For the purpose of guarding against margin calls, T-bonds are very nearly as good as legal tender, so you do not impose any great drain on any actual cash flow. But when the mattress-stuffing people discover that the recession is over and attempt to take their money out of their mattresses, they will find that when it comes to doing anything other than covering your ass from a margin call, T-bonds are considerably less useful than legal tender.

So by issuing T-bonds during your deficit spending, you can obtain greater control of the process of returning the money stuffed in mattresses into the political economy.

There is also a third possibility of your list - the crisis is so deep that no Keynesian spending, however gross, would wake the conventional economy up.

This would have nothing to do with the depth of the crisis, and everything to do with the underlying economic fundamentals of the crisis.

There are four factors of production that are required to make a modern industrial state work: Raw materials, labour, capital and financial assets. "Economic crisis" is normally taken to mean that there is unemployed labour, because unemployed labour creates real hardship for real human beings, something that unemployed raw materials, financial assets or capital typically does not.

Now, if we define an economic crisis as a surplus of labour relative to requirements, then it must mean that one of the other three factors of production forms a bottleneck.

If and only if the bottleneck is a lack of financial assets in the right places at the right times, Keynesian deficit spending can help. But if the shortage is in financial assets, as opposed to real capital or raw materials, then there is no crisis so deep that adequate Keynesian spending will not bridge the shortage of financial assets.

If, on the other hand, the shortage is in real capital or raw materials, then there is no crisis so shallow that it can be bridged by Keynesian spending, because under a shortage of raw materials or real capital, Keynesian spending would not be addressing the problem.

The problem is not just one of on what the money is spent but also one of who gets the money. We need to remember that the "Great Recession" is largely the result of those who have wealth being afraid to invest and unable to practically consume more than a tiny fraction of their existing income. Increasing taxation on this tiny group and then spending those revinues for socially useful purposes would be appropriate in these circumstances.

Giving TBTFs more money, as has been done with TARP, is only useful to prevent their insolvency from becoming undeniable. Since it is their excesses and folly that has let to the GFC, it might be a good idea to let them be "resolved" instead of giving them more money.

On the other hand, money that is credited to those without wealth in return for labor provided performing socially needed tasks pays for the accomplishment of those tasks AND gets spent on consumption, which will boost the economy. It might also be sensible to enact policies that result in the return of some of the manufacturing operations that have been shipped abroad so as to re-create a more balanced economy.

As to your perception that the conversation is going sideways, it seems that what would be forward to you would be towards more "austerity". That path seems very likely to end in a death spiral of debt-deflation. If we want to get out of the liquidity trap, etc. in which we find ourselves we need a combination of fiscal and monetary policies and re-regulation that begins to reverse the massive wealth disparities that current policy has generated and that undoes some of the damage done by globalization.

Of course the one thing that has not been explicitly discussed here is the role of debt and debt to GDP ratios in the existing crisis. In Neo-Classical Economics debt is not a consideration. In the real world it is. The Fed and the ECB are both pursuing policies that are aimed at facilitating the use of bank created debt to extract the last drop of blood from the body economic in their respective areas. This has, in the USA, been accomplished via a giant control fraud where the financial sector first, starting in the '80s, looted and destroyed the Savings and Loan Associations and turned mortgage issuance into a game for commercial banks, the Fed provided increasingly cheap money through low interest rates, anti-regulators were appointed to all significant regulatory bodies and then Congress repealed Glass-Steagall. The result is that money creation came to be a more lucrative for profit exercise by the big banks on Wall Street in conjunction with the shadow banking system.

Finance turned malignant and banks no longer loaned money for productive enterprises. Instead they financed the buy-out of existing productive enterprises and shipped the production to China, etc. Most of the debt they have created through serial bubbles is essentially fraudulent, or counterfeit debt, as Jerome would have it. We are now in the situation that the debt has grown to a point, in 2007, that it could no longer be serviced by borrowing the interests for "interest only" payments and we have entered a deleveraging cycle where the economy is contracting and the overall situation is deflationary.

It is not possible to repay the accumulated debt at this point, nor should most of it be repaid -- except for the unfortunate fact that bogus assets have been sold to all of the pension funds, etc. Given those facts the banks and financial institutions involved should be resolved, the executives prosecuted and what is owed to the banks canceled while what the banks have paid out to officers should be clawed back to pay for the damages.

That is what should be done. Then we could begin to recover from the damage that has been inflicted. We will see what actually happens. Were we to do what needs to be done we could then turn to investing in projects that provide renewable energy and transportation based on that energy. That is truly the vital task, but the ongoing looting is preventing us from getting there. Worse, in the USA and Europe all of the major political parties have bought into the idea that what must be saved is the very financial system that is continuing to suck the life out of the economies.

Two links give a good perspective on these processes:

Steve Keene's AMI Talks at the recent American Monetary Institute in Chicago in FLV format -- the talk by Steve and the talk by Michael Hudson are both worth the effort of watching. Unfortunately transcripts don't seem to be available.

Steve has created stock-flow economic circuit models of economies that actually produce results very similar to the crash we had in 1929 and 2008 and Steve focuses on the role of debt. He talks about "why credit money doesn't have to crash and why it always does." Hint -- it is the motivations of the bankers. He also shows some very elegant dynamic models of the economy based on stock and flow and resolves a dilemma of neo-classical economics, which cannot account for profits! and which is inherently prone to crashes by showing where it goes wrong.

Michael Hudson's talk brings the criminal element into the discussion Steve started. His thesis, well, one of them, is that banking has essentially been turned into a criminal enterprise, but we just are not prosecuting the crime. Hudson provides an insider's view of how all this happened. Very worth while.

The other is Chris Whalen's presentation at an American Enterprise Institute gathering that also included Nouriel Roubini. Several good talks there, but follow the instructions to get to Chris's presentation. He explains why the US TBTFs are going to fail in 2011 and he urges, in effect, new leadership that will repudiate the bogus debt and write it down instead of pretending it is real.

An understanding of these processes and a means of clearly presenting this information to a lay audience has been my goal for a while now.

An understanding of these processes and a means of clearly presenting this information to a lay audience has been my goal for a while now.

well it's working for me. your explanations are never complicated when they could be simple. the subject of the history of economics was never high on my pleasure-reading list, it's bafflingly immense, like the numbers it's throwing around these days.

you take a heavier-than-lead subject and make it easier to fathom, inch by inch.

your analyses are tireless, and never tiresome. your diaries and comments help fill in many dots, and connect spaces, you're a natural educator.

i deeply appreciate it.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

How much do the governments "spend money into creation"? The way its happening is through greater national debt

This is a political decision, not an unalterable fact about the monetary system. Sovereigns have dated liabilities to their own citizens because it suits their political needs, not because they have to issue bonds, nor even because they have to honour bonds previously issued. That's the whole point of being sovereign.

It can suit their political need because it exchanges liquid legal tender for rather less liquid sovereign bonds. Or it can suit their political needs because they have made the political decision to run the economy as if they were operating under a Gold Standard. The former can be smart or can be dumb. The latter is always insane.

the actual sovereign (is?) money. That's where the power lies, under everyone's consent.

Well, I agree that money is the organizing principle behind our societies today, but I hardly believe that more than a very few provide any meaningful consent to this. Consent has to be informed to be meaningful. I strongly suspect that it is not entirely accidental that there is a pervasive misunderstanding about the nature of money in our society. Few people even understand fractional reserve banking and "loaning money into existence", after all, and that is just the beginning.

The people do not understand what the money is, but everyone knows that you have to make money to live. And they would do anything (of what they know) for money, even if that does not bring better living. In the 1990s it was quite baffling how eager East Europeans were to emigrate for a "better" job to the West, even if they had (still then) most of what they would normally need.